The Tyranny of Consulting

Theyre more influential than ever in deciding how
assets are allocated across fund managers, according to Spencer Mindlin, an analyst with research
firm Aite Group. With thousands of firms vying for
consultants attention, only a small percentage even make
it through the door to meet with these gatekeepers to clients
overseeing trillions of dollars.

We sit in the really enviable position of seeing all
the offerings that are out there in the marketplace, says
Steve Foresti, chief investment officer of Wilshire Consulting.
There is so much competition.

A Greenwich Associates report from last year confirms
Forestis belief: In the U.S. in 2015, 86 percent of
institutional investor relationships were intermediated by
investment consultants, the research firm said. At 92 percent,
the number was even higher in the U.K. These consultants are
extraordinarily selective, shortlisting less than
10 percent of the managers tracked in their databases,
Greenwich Associates noted in the report on best practices for meetings with
consultants. Only 380  or 16 percent  of the
average 2,433 U.S. equity managers followed during searches got
a meeting in a consultants office, and just 3 percent
were shortlisted, the report shows.

The role of the consultant has grown as markets have become
more complex and yield harder to find in todays
low-interest-rate environment, says Foresti, adding that as a result,
Wilshires outsourced CIO business has been growing. The growth
comes as the investment management industry is under increasing
pressure to produce gains that beat low-cost funds tracking
indexes such as the S&P 500. Were big fans of
low-cost implementation, and that would certainly include a
fair amount of passive, large-cap U.S. equity, says
Foresti. Still, he says many investors need help navigating
alternative strategies to build out their portfolios.

Aite Groups Mindlin agrees, saying that consultants
filter through the many boutique hedge funds and alternative
managers specializing in areas such as private equity, real
estate, and emerging markets  work that may be
overwhelming for resource-strapped investors to manage.

Institutional investing has gotten more sophisticated
and therefore they need more help in finding asset managers to
fit into a more complicated allocation process, he says.
Theyre trying to find asset managers that have
niche expertise. Its impossible for them to do all the
searching themselves.

In its 2017 Alternative Investment Survey, Deutsche Bank found that disappointing hedge fund
returns were the single largest constraint for investors
considering commitments to the asset class, a view most widely
held by investment consultants and advisers.

With Barclays estimating in its February global hedge fund
industry outlook that investors will make almost $300 billion
of gross hedge fund allocations in 2017, fees are likely to be
a focus in discussions.

Spending time to help change the fee landscape is an
incredibly big topic, says Marlin Naidoo, head of
Deutsches capital introduction and hedge fund consulting
for the Americas.

Beyond scrutinizing performance, Mindlin says, consultants
have become a more important part of the selection process
because investors need help scrutinizing operational risks
revealed during the 2008 financial crisis. Before the collapse
of Lehman Brothers, hedge funds typically set up a prime
brokerage account with a single Wall Street bank, he says,
adding that managers then began spreading their assets among
more than one firm to reduce the risk of all their assets being
tied up in a failed prime broker.

Post-crisis, theyre much more concerned with
operational due diligence, says Naidoo.

Despite all their help navigating the complexities of
markets, in his 2017 letter to shareholders, billionaire investor and
Berkshire Hathaway chairman Warren Buffett questioned the value
of consultants. Buffett wrote that with large fees flowing to
consultants for recommending small managerial shifts every year
or so, repeatedly telling clients to keep adding to an index
fund replicating the S&P 500 would be career
suicide.

But consultants neednt worry too much.

The financial elites  wealthy
individuals, pension funds, college endowments, and the like
 have great trouble meekly signing up for a financial
product or service that is available as well to people
investing only a few thousand dollars, the Oracle of
Omaha said in his letter. Human behavior wont
change.

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